Here's What The 'Fiscal Cliff' Tax Deal Is Starting To Look Like

THE election dust had barely settled when Barack Obama and his
Republican adversaries returned to their traditional rhetoric
over taxes. "Raising tax rates is unacceptable," John Boehner, the Speaker of the House of
Representatives, declared on November 8th. The next day Mr Obama
said "I am not going to ask students and seniors and middle-class
families to pay down the entire deficit while people like me,
making over $250,000, aren’t asked to pay a dime more in taxes."

Optimists, however, took note of what the men did not say: Mr
Boehner did not rule out raising tax revenues. Mr Obama did not
explicitly insist that the two top income tax rates, now 33% and
35%, return to 35% and 39.6%, as they are scheduled to do when
George W. Bush’s tax cuts expire at the end of this year.

This has aroused hopes that the two men can find common ground on
tax reform that leaves marginal tax rates where they are while
raising new revenue by curbing credits, deductions and exemptions
(collectively called tax expenditures), which distort economic
activity. Numerous such proposals have been aired in recent
years, some of which Republicans hated because they raised new
revenue; others Democrats rejected because they gave a windfall
to the wealthy.

One way this could be done is to target deductions that primarily
benefit the rich. During the election campaign, Mitt Romney proposed paying for big marginal
rate cuts by setting a cap on total deductions. The Tax Policy
Centre, a think-tank, reckons a cap of $50,000 would raise $749
billion over ten years, comparable to the $800 billion that Mr
Boehner entertained during failed negotiations with Mr Obama in
2011. Importantly, this fix would make the tax system much more
progressive: 80% of the additional money would come from the top
1% of earners. This has helped draw interest from some Democrats.

A slightly different proposal by Martin Feldstein, a prominent
Republican economist, and Maya MacGuineas of the Committee for a
Responsible Federal Budget, a think-tank, would cap the tax
benefit of itemised deductions at 2% of income for all
households. Mr Feldstein reckons that would raise more than $2
trillion over ten years, although almost all families would pay
more tax, not just the rich.

As it happens, Mr Obama has already proposed curbing tax breaks
for the wealthy (see table). His budget would restore the limits
on their exemptions and deductions that Mr Bush’s tax cuts
eliminated. A separate proposal would limit the tax benefit of
deductions for mortgage interest, charitable contributions,
municipal bond interest, employer-provided health care, and
individual retirement plans to 28%, even for taxpayers paying a
35% or 39.6% marginal rate.

Despite their superficial appeal, such proposals face daunting
obstacles. Foremost is that they may not raise enough revenue to
satisfy Mr Obama. In the run-up to formal negotiations due to
begin on November 16th, Mr Obama signalled he would begin by
asking for $1.6 trillion in revenue over the coming decade, as
his latest budget does. At a press conference on November 14th,
he said "it’s very difficult to see how you make up" the revenue
lost from failing to restore the higher rates just by closing
deductions: "The math tends not to work." But, he added, "I’m not
going to just slam the door" on alternatives that accomplish what
he wants.

The second obstacle is the calendar. Politicians are racing
against a year-end deadline when Mr Bush’s tax cuts and other
stimulus measures expire and automatic spending cuts are
triggered. The collective fiscal tightening, if sustained, could
push the economy into recession. Even if the two sides agreed
that tax reform would be the main vehicle for raising more
revenue, the task would be too complex to accomplish by year-end.
A smaller deal would be needed to avert the cliff, leaving bigger
tax and entitlement changes for next year. The challenge then
would be to bind the hands of both parties to consummating a big
deal next year.

For all the appeal of curbing loopholes, each has vocal and
influential defenders. When the Obama administration first
proposed its 28% cap on tax expenditures, "we got killed,"
Peter Orszag, Mr Obama’s first budget
director, recalls, in particular by charities and non-profit
groups. For Mr Obama and Mr Boehner, finding agreement with each
other may very well prove to be the easy part.